Small innovators: No risk, No return

• Published in: Journal of accounting & economics 2022-08, Vol.74 (1), p.101492, Article 101492
• Main Authors: Stoffman, Noah, Woeppel, Michael, Yavuz, M. Deniz
• Format: Article
• Language: English
• Subjects: Cost of equity; Disclosure; Financial constraints; Information asymmetry; Innovation
• ISSN: 0165-4101; 1879-1980
• DOI: 10.1016/j.jacceco.2022.101492

We show that small innovators (i.e., small firms with recent patent grants) earn higher future returns than small non-innovators. However, we find no such innovation premium among large firms. The higher returns are driven by risk, not underreaction to announcements of recent patent grants. We find that being small and innovative interacts with financial constraints to explain the higher returns. These interactions are more important in the presence of greater information asymmetry. The higher cost of equity among small innovators has implications for their investment, growth, and capital structure decisions. •We use patents granted by the USPTO to create the largest dataset of patents matched to publicly-traded firms.•Small innovators (i.e., small firms with recent patent grants) earn higher future returns than small non-innovators.•The higher returns are driven by risk, not underreaction due to information processing costs.•Small innovators are riskier because of their reliance on external funding and strategic alliances.•Information asymmetry exacerbates the effect of reliance on external parties on the cost of equity.